COMMENT
Where Trouble Lies In 2005

It's that time of year again. Anybody opening a newspaper over the Christmas break will no doubt see a list of top tips for 2005, assuming of course they get to the money pages!

But rather than focus on fanciful stock ideas for 2005, it should pay to reflect instead on your current portfolio. Before looking for fresh investment opportunities, investors must first weed out those stocks that are well past their sell-by dates. Remember this -- almost all of the really big trouble you will experience in the next twelve months will be in your portfolio right now. So prior to making any investments in 2005, it's worth reviewing the grounds on which why you should sell a share.

First off, sell when you've made a mistake. How many companies in your present portfolio have not lived up to your original expectations? Did you overestimate a company's management team or competitive position? Did you underestimate a company's financial problems or rivals? If you've bought into a company that has quickly proved your initial judgement wrong, get rid.

Secondly, bear in mind that companies evolve. They hopefully keep on growing and growing over time. But things change. One day, you could part own quite a different company from the one you invested in many years ago. It may have made an ill-advised acquisition, the management team may have jumped ship, or the company's marketplace may have started to mature. Either way, if the company's 'story' has fundamentally changed for the worse, sell out.

And thirdly, consider valuation. If there was one lesson from the dotcom bubble, it was surely 'valuation matters'. A company's value is based on the expectation of its future profits. If the stock market is expecting far too rosy times ahead for your company, think about selling. Admittedly, there are a few notable businesses around that have always looked overvalued, but still continue their growth paths unhampered. However, more often than not, fast growing companies suffer a reversion to the mean over the long term. And a falling growth rate usually means a falling valuation.

Only after you've properly evaluated each member of your present portfolio with the above criteria should you commence your 2005 stock picking.

A version of this article was published in 2003.